Accounting for Corporations Chapter 11 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Wild, Shaw, and Chiappetta Financial & Managerial Accounting 6th Edition Wild, Shaw, and Chiappetta Financial & Managerial Accounting 6th Edition

Privately Held Publicly Held Ownership can be Corporate Form of Organization Existence is separate from owners An entity created by law Has rights and privileges C 1 2

Characteristics of Corporations Advantages  Separate legal entity  Limited liability of stockholders  Transferable ownership rights  Continuous life  Lack of mutual agency for stockholders  Ease of capital accumulation Disadvantages  Governmental regulation  Corporate taxation C 1 3

Corporate Organization and Management C 1 Corporate governance is the system by which companies are directed and controlled. Board of Directors Stockholders President, Vice President, and other Officers Employees of the Corporation 4

Ultimate control Selected by a vote of the stockholders Overall responsibility for managing the company Corporate Organization and Management C 1 Stockholders usually meet once a year 5

Rights of Stockholders  Vote at stockholders’ meetings (or register proxy votes electronically)  Sell stock  Purchase additional shares of stock  Receive dividends, if any  Share equally in any assets remaining after creditors are paid in a liquidation C 1 6

Each unit of ownership is called a share of stock. A stock certificate serves as proof that a stockholder has purchased shares. Stock Certificates and Transfer When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate. C 1 7

Basics of Capital Stock Total amount of stock that a corporation’s charter authorizes it to sell. Total amount of stock that has been issued or sold to stockholders. C 1 8

Par value is an arbitrary amount assigned to each share of stock when it is authorized. Market price is the amount that each share of stock will sell for in the market.  Basics of Capital Stock Classes of Stock  Par Value  No-Par Value  Stated Value C 1 9

Par Value Stock On June 5, Dillon Snowboard’s, Inc. issued 30,000 shares of $10 par value stock for $12 per share. Let’s record this transaction. Issuing Par Value Stock P 1 10

Issuing Par Value Stock P 1 11

Issuing Stock for Noncash Assets Par Value Stock On June 10, 4,000 shares of $20 par value stock for land valued at $105,000. Let’s record this transaction. P 1 12

Dividends Stockholders Cash Dividends Corporation To pay a cash dividend, the corporation must have: 1.A sufficient balance in retained earnings; and 2.The cash necessary to pay the dividend. Regular cash dividends provide a return to investors and almost always affect the stock’s market value. P 2 13

Accounting for Cash Dividends Three Important Dates Date of Declaration Record liability for dividend. Date of Record No entry required. Date of Payment Record payment of cash to stockholders. P 2 14

Date of Declaration Record liability for dividend. Accounting for Cash Dividends On January 9, a $1 per share cash dividend is declared on Z-Tech, Inc.’s 5,000 common shares outstanding. The dividend will be paid on February 1 to stockholders of record on January 22. P 2 15

No entry required on January 22, the date of record. Date of Payment Record payment of cash to stockholders. Accounting for Cash Dividends On January 9, a $1 per share cash dividend is declared on Z-Tech, Inc.’s 5,000 common shares outstanding. The dividend will be paid on February 1 to stockholders of record on January 22. P 2 16

Deficits and Cash Dividends A deficit is created when a company incurs cumulative losses or pays dividends greater than total profits earned in other years. P 2 17

Stock Dividends Why a stock dividend?  Can be used to keep the market price on the stock affordable.  Can provide evidence of management’s confidence that the company is doing well. A distribution of a corporation’s own shares to its stockholders without receiving any payment in return. Small Stock Dividend Distribution is  25% of the previously outstanding shares. Large Stock Dividend Distribution is > 25% of the previously outstanding shares. P 2 18

Recording a Small Stock Dividend Quest has 10,000 shares of $1 par value stock outstanding. On December 31, Quest declared a 10% stock dividend, when the stock was selling for $15 per share. The stock will be distributed to stockholders on January 20. Let’s prepare the December 31 entry. 1,000 × $10 par Capitalize retained earnings for the market value of the shares to be distributed. (10,000 × 10% = 1,000 × $15 = $15,000) P 2 19

Before the stockdividend. After the stockdividend. P 2 20

Recording a Small Stock Dividend Quest has 10,000 shares of $1 par value stock outstanding. On December 31, Quest declared a 10% stock dividend, when the stock was selling for $15 per share. The stock will be distributed to stockholders on January 20. Let’s prepare the January 20 entry. P 2 21

Recording a Large Stock Dividend Capitalize retained earnings for the minimum amount required by state law, usually par or stated value of the shares. (10,000 × 30% = 3,000 shares × $10 par value = $30,000) Quest, Inc. has 10,000 shares of $1 par value stock outstanding. On December 31, Quest declared a 30% stock dividend. The stock will be distributed to stockholders on January 20, Let’s prepare the December 31 entry. P 2 22

Common Stock $20 par value 100,000 shares Old Shares New Shares Common Stock $10 par value 200,000 shares Stock Splits A distribution of additional shares of stock to stockholders according to their percent ownership. P 2 23

Preferred Stock A separate class of stock, typically having priority over common shares in... – Dividend distributions – Distribution of assets in case of liquidation Usually has a stated dividend rate Normally has no voting rights C2 24

vs.NoncumulativeCumulative Dividends in arrears must be paid before dividends may be paid on common stock. (Normal case) Undeclared dividends from current and prior years do not have to be paid in future years. Preferred Stock Consider the following Stockholders’ Equity section of the Balance Sheet. The Board of Directors declares $5,000 of dividends in In 2015, the Board declared and paid cash dividends of $42,000. C2 25

Preferred Stock C2 26

vs.NonparticipatingParticipating Dividends may exceed a stated amount once common stockholders receive a dividend equal to the preferred stated rate. Dividends are limited to a maximum amount each year. The maximum is usually the stated dividend rate. (Normal case) Preferred Stock Reasons for Issuing Preferred Stock  To raise capital without sacrificing control  To boost the return earned by common stockholders through financial leverage  To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low C2 27

Treasury Stock Treasury stock represents shares of a company’s own stock that has been acquired. A corporation might acquire its own stock to: 1. Use its shares to buy other companies. 2. Avoid a hostile takeover. 3. Reissue to employees as compensation. 4. Support the market price. P 3 28

Purchasing Treasury Stock Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet. Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet. On May 1, Cyber, Inc. purchased 1,000 of its own shares of stock in the open market for $11.50 per share. P 3 29

Selling Treasury Stock at Cost On May 21, Cyber sold 100 shares of its treasury stock for $11.50 per share. P 3 30

Selling Treasury Stock Above Cost On June 3, Cyber, Inc. sold an additional 400 shares of its treasury stock for $12 per share. P 3 31

Selling Treasury Stock Below Cost On July 10, Cyber sold an additional 500 shares of its treasury stock for $10 per share. P 3 32

Statement of Retained Earnings Retained earnings is the total cumulative amount of reported net income less any net losses and dividends declared since the company started operating. Legal Restriction Most states restrict the amount of treasury stock purchases to the amount of retained earnings. Contractual Restriction Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings. Restricted Retained Earnings C 3 33

Prior Period Adjustments Prior period adjustments are corrections of material errors in past years’ financial statements that result in a change in the beginning balance of retained earnings. C 3 34

Statement of Stockholders’ Equity This is a more inclusive statement than the statement of retained earnings. C 3 35

Option purchase price $30 per share. Stock Options Market price of stock $75 per share. The right to purchase common stock at a fixed price over a specified period of time. As the stock’s price rises above the fixed option price, the value of the option increases. Options are given to key employees to motivate them to: focus on company performance, take a long-run perspective, and remain with the company. C 3 36

Global View U.S. GAAP and IFRS have similar procedures for issuing common stock at par, at a premium, at a discount, and for noncash assets. Accounting for and reporting cash dividends, stock dividends, and stock splits, are consistent under both U.S. GAAP and IFRS. Accounting for treasury stock is consistent under both U.S. GAAP and IFRS. Companies do not report gains or losses on transactions involving their own stock. Preferred stock that is redeemable at the option of the preferred stockholder is reported between liabilities and equity under U.S. GAAP, but it is reported as a liability under IFRS. Also, the issue price of convertible preferred stock (and bonds) is recorded entirely under preferred stock (or bonds) and none is assigned to the conversion feature under U.S. GAAP. However, IFRS requires that a portion of the issue price be allocated to the conversion feature when it exists. 37

Earnings Per Share Basic earnings per share = Net income - Preferred dividends Weighted-average common shares outstanding Earnings per share is one of the most widely cited accounting statistics. A 1 38

Price-Earnings Ratio Price– earnings ratio = Market value (price) per share Earnings per share This ratio reveals information about the stock market’s expectations for a company’s future growth in earnings, dividends, and opportunities. A 2 39

Dividend Yield Dividend yield = Annual cash dividends per share Market value per share Tells us the annual amount of cash dividends distributed to common stockholders relative to the stock’s market price. A 3 40

Book Value per Common Share Book value per common share = Stockholders’ equity applicable to common shares Number of common shares outstanding Reflects the amount of stockholders’ equity applicable to common shares on a per share basis. A 4 41

Book Value per Preferred Share Book value per preferred share = Stockholders’ equity applicable to preferred shares Number of preferred shares outstanding Reflects the amount of stockholders’ equity applicable to preferred shares on a per share basis. A 4 42